Dr. Blake Clayton is a member of the Integrated Oil and Gas Equity Research team at Citigroup. Prior to joining Citi, he was a fellow at the Council on Foreign Relations in New York. He has a doctorate from Oxford University.

With oil prices climbing, the Obama administration has continually reminded Wall Street that the president might dip into the Strategic Petroleum Reserve (SPR), the nation’s emergency oil stockpile, to help calm a painful rise in prices. Since February, President Obama, Energy Secretary Chu, Treasury Secretary Geithner and Interior Secretary Salazar have all stressed that the president, whose sole authority it is to tap the U.S. SPR, stands ready to sell oil from these government-controlled reserves onto the market at any time. Nearly all emphasized that the option to intervene in the market is always “on the table,” as if letting the option dangle. President Obama has emphasized that the oil release could be “set in motion in a few days, not weeks, if needed.” The apparent message from the White House to market participants has come through loud and clear: Push oil prices any higher and we may turn on the spigot, making you sorry that you did.

Such assertive language evinces a growing belief among pundits that a more hawkish tone from the White House about the SPR may render it a more powerful weapon. A former head of the U.S. Energy Information Administration has argued that proposing to tap the reserve can “psychologically help the market”—presumably keeping prices lower—by reassuring traders that “the reserve is there” and ready to flood the market at a moment’s notice. A Congressional Research Service report published last year similarly cited the “psychological leverage [the SPR] exercises on prices.” Several members of Congress have echoed these arguments, with one calling on President Obama to use the emergency stockpile more aggressively to scare away “speculation in the oil markets” stoking prices. Some believe the White House has already begun to hold the threat of a release over traders as a means of helping to contain prices. A September Financial Times analysis described the Obama Administration’s continual threats of an imminent SPR release as bearing a “remarkable resemblance” to the Federal Reserve’s attempt to carefully craft its public utterances in order to influence financial markets.

The temptation for President Obama to heed this siren song, especially in an election year, is strong but perilous. It is true that a looming threat from the White House may have the power to soften today’s prices to a small degree by affecting traders’ perceptions of future market conditions. But unlike the Fed, which has the authority to anchor short-term interest rates and conduct open-ended Treasury purchases, the SPR grants the President no such sway in the oil market. The SPR is only equipped to remedy short-term supply disruptions. The risk of unintended consequences from using it any other way is high. A release aimed at guiding prices could actually send a bullish signal to the market about current and future supply-and-demand imbalances, suggesting OPEC’s capabilities are no longer sufficient to balance the market. In addition, should the release be structured as a loan rather than an outright sale, effectively borrowing future oil today, market participants would perceive a more bullish forward balance. At the end of the day, no amount of fiddling with the SPR can replace sound energy policy.

One up on Wall Street

The authority to tap the SPR gives the President a unique position of power within the oil market. For one thing, the White House has latitude in deciding when to draw down the SPR; there is no clear trigger mechanism that dictates when it can do so. The law only requires that the President deem that a “significant reduction in supply” has caused a “severe” increase in oil prices that could have a “major adverse impact on the national economy.” Moreover, because a release can cause them tremendous profit or loss, market participants may alter their buying and selling decisions depending on how likely they believe a future release to be. As a result, even an intimation from the White House that it plans to release oil from its strategic reserves has the potential to move the market.

The Obama administration appears to be well aware of this fact, which has likely led it to take a strategic approach to its public statements about the SPR. These reminders have fueled constant speculation among market participants. Last year’s oil release, conducted a few months after civil war reduced Libyan production, proved that the Obama administration is willing to tap the SPR regardless of whether there is a clear consensus among outside experts that a “severe supply disruption” exists. Any insinuation about another release carries extra credibility simply because President Obama has proven he’s willing to pull the trigger. What is more, painfully high oil prices—brought about by declines in Iranian oil exports (due to US and EU sanctions) and in exports from other non-OPEC producers (such as South Sudan, Yemen, Syria, Brazil and the North Sea)—have given President Obama a plausible case for intervention. In addition, growing US domestic oil production and shrinking to stagnating US oil demand have reduced US oil import dependency. As a result, the required inventory holdings against future disruptions have declined, giving plausible cover for an SPR sale. And lest anyone argue that the White House would never call on the SPR so soon before Americans head to the polls, one need only recall that President Clinton tapped the reserves just six weeks before the November 2000 election. (Apparently cheaper gas wasn’t enough to do the trick for then-Vice President Gore.)

A little more conversation

Can signals from the White House about its intentions regarding the SPR actually affect today’s oil prices? Trying to alter market expectations with such a blunt tool is akin to trying to perform surgery with a butter knife: useful at the margins, perhaps, but hardly a powerful instrument. That said, oil prices at any given moment are a product of the market’s weighing the likelihood of all possible future scenarios. To the extent that Washington can cause market participants to lower the probability they ascribe to much higher prices down the road, a credible threat could have a modest impact on today’s prices.

This effect on prices should not be overstated, though. Not all threats are created equal. The market must believe that the President has incentive to back words with actions. The administration’s prior actions, how well the economy is faring, and the willingness of the country’s foreign allies to take part in the release all factor in. In addition, China’s actions with respect to their own SPR will affect the efficacy of any release. The credibility of the threat will likely deteriorate over time, too: If the threats are fulfilled, the willingness for subsequent SPR releases would decline as inventories decline; if they go unfulfilled, the market will call the President’s bluff. Without knowing the size, duration, type of oil or whether the release is a loan or a sale, the effect of a threat on the market will invariably be modest. Yet for policymakers to reveal much about a release beforehand would be dangerous. Market participants often test government officials to make good on their claims; the ongoing pressure facing sovereign debt issuers in Europe is a case in point. Should a long-threatened SPR release fail to impress, the sharks may start to smell blood, which could wind up making matters worse.

There could be other unintended consequences. An emergency oil release by government officials shines a spotlight on shortages in the market. It can also imply that the White House and its allies in the International Energy Agency are skeptical that OPEC countries are willing and able to keep prices in check. Tapping the SPR also risks masking the most valuable signal of high prices: that greater oil production, or less demand, or both, is needed. Habitual intervention by the federal government could delay that day of reckoning until the problem becomes more critical, though it is hard to imagine that today’s prices do not already send a powerful signal to produce more and consume less oil. Lastly, though highly unlikely given how plentiful strategic oil stocks are right now, to the extent that lower SPR holdings reduce future responsiveness, pre-emptive SPR release could lead to trouble if and when a real problem strikes.

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